governance, political economy, institutional development and economic regulation

Archive for November, 2014

We are, for the most part, what institutions make us. Some of us, who are exceptional, disrupt the status quo and change the universe. But generally, such special talents are best in small doses. India has too little of compliance with formal institutional norms and a little too much, of the libertine spirit. Of course, when it comes to informal institutions like caste, religion or class the reverse is as forcefully true.

How can we rework our formal institutions?

What ails most institutions in India is that they lack charismatic leaders and citizens do not see the “value” attached to them. Parliament, for instance, is commonly regarded as a troublesome, distant cousin, who has to be invited to weddings, but from whom most decent folk would run a mile. The Judiciary, even though it has acted repeatedly for the poor and marginalised, is viewed with trepidation, because of the serpentine coils of due process it has wrapped itself in. The Police has traditionally been just plain bad news but now, even the civil bureaucracy, commands scant respect.

One reason for the decline of institutions is that most are closely associated with the legacy of the colonial government. Indeed many are still housed in the same buildings. Most still follow the same rules, which protect the State’s, rather than the citizens’, interests.

But more fundamentally, the conundrum is that India’s Independence struggle was not against the institutions embodying the “Raj”. It was against the foreigners in power at the time. We have retained all the vestiges of the colonial government; a centralized government; symbols of distant, almost princely privilege, for the elected representatives and an under-regulated (albeit also increasingly poorly protected) bureaucracy, trained and organized, to subsume the difference between public and self-interest.

The demise of institutions is a familiar lament. Can it be reversed and what can Budget 2015 do about it? Clearly, the decline is not related to a lack of finances, so change in resource allocation norms provides no solutions. Since 1991, the Budget Speech has become an instrument for announcing big ticket policy changes and this is where it could help. There are three major policy changes for building institutions, which merit inclusion in the Budget Speech of the FM.

First,build the autonomy of Municipal Government. ModiGov is focused on urban areas for economic growth. This is sensible. 700 million (50%) Indians, many of them not yet born, are expected to live in urban areas by 2034. Projectised resource allocations for roads, bullet trains, electricity, water, housing and “smart” cities are being made.

But allocating resources is just the first step. Unless the institution of Municipal Government is restructured, it is unlikely, that the good governance environment required to use these additional resources effectively, can be created.

Local problems need local solutions. But state (provincial) governments are loath to devolve powers downwards. India is a federal democracy. The Union can only persuade and incentivize. It cannot direct state governments to devolve powers.

The FM should use Budget FY 2015 to provide incentives for State Governments to devolve fiscal and administrative powers and functions to municipalities. One option could be a Challenge Fund, with a replenishing, annual corpus of Rs. 10,000 crores (USD 1.5 billion), open to competition amongst the Fifty Four cities, each with a population exceeding one million. Every year, the best five to ten devolution proposals, received from state governments, could be selected. Each selected city would get a direct, long term soft loan, against achievement of milestones, from the Union government via a Special Purpose Vehicle equal to 50% of the average state government grants provided over the previous three years.

This is a “win win” because it enables fund-strapped State Governments to redeploy their funds to other areas, whilst also ensuring more autonomy to dynamic and growth oriented States and cities.

Why is municipal autonomy important? Pan-national schemes are too clunky to be effective. Remote management undermines local participation, ownership and decision making. Meddling in city governance, by state governments, is usually motivated to extract “rent” or some other form of private benefit.

Politically, such devolution makes sense for the BJP, which is a party dear to urban hearts. In fact, rather than go for elections to Delhi State immediately, the Union government should first merge the three municipalities of Delhi into Delhi State, making it the first City State of India. The Union government could retain direct control of the Lutyens Delhi area, where the rich and the powerful live.

Second, is to build the autonomy of regulatory institutions and signal that where a regulator exists the government shall defer to the collective wisdom of that institution. Unless this is done, autonomous regulation cannot be effective. Making regulators effective is key to building investor confidence.

The prime example is the Reserve Bank of India (RBI) which is one of the oldest autonomous regulators.

The positive regulatory experience with the RBI (1934) and then with the Securities Exchange Board of India (SEBI) (1992), encouraged India to expand the area of autonomous regulation for governing Telecommunications (1997); Electricity (1998); Insurance (1999); Anti –Trust/Competition (2002) and Pension Funds (2013).

Our institutional record on managing macro-economic stability is poor. High inflation not only hits the poor the most but also erodes the confidence that the government is in control of the economy. Line managers in government have a hands-off approach to using funds effectively. The government seems complicit in being less than adequately focused on inflation. Public wages are 100% inflation proofed, whilst the poor and employees in the private sector have no such safeguards. Large scale public failures to produce domestic natural resources (oil, gas and coal) in sufficient volume, result in the import of inflation when international commodity prices are high. Poor infrastructure increases the cost of transit. Draconian regulations stifle competition and markets and increase transaction cost.

FM Jaitley needs to clear the air on the institutional arrangements for managing inflation and interest rates. The FM said in his maiden Budget Speech in July 2014 “We look forward to lower levels of inflation…” and asserted the need for “….macro-economic stabilization that includes lower levels of inflation”.

Both objectives have been substantively achieved. The trend is heartening and the FM is entitled to take credit for it. But in the aftermath of this success, there have been discordant voices on interest rates. The RBI Governor has consistently said that windfall benefits from lower international petro and food prices alone should not be the basis for reducing interest rates. The FM has publicly advocated a divergent policy of reducing interest rates to stoke growth.

This public discord is avoidable noise. It perturbs perceptions and muddies expectations. It makes a “dear money” policy less effective. It postpones investments, as entrepreneurs wait for the expected lowering of interest rates. Public unanimity on monetary/interest rate policy issues, with the RBI Governor taking the lead, seems the best way forward.

The Budget Speech provides a good occasion to underline the autonomy of RBI and to give it credit for monetary policy management. The FMs support for an autonomous RBI is bound to be reflected in the relations between other line ministers and their autonomous regulators.

A big gap in the regulatory architecture is the absence of an autonomous regulator for fossil fuels (coal, gas and oil). Coal, gas and oil have consequently suffered from regulatory uncertainty and mismanagement. This is in sharp contrast to the manner in which Central Electricity Regulatory Commission and Telecom Regulatory Authority of India have rationalized the bulk electricity and telecom markets, respectively.

Announcing a time bound plan to legislate an integrated fossil fuel regulator (Federal Energy Regulatory Commission of the US provides a good model), builds on the existing trend to club energy related departments-Coal, Electricity and Renewable Energy have been clubbed under the amiable and eminently qualified Minister, Piyush Goyal. This step would also signal the intention of the government to reverse the politicization of natural resource allocations, whilst also inflation proofing the economy from supply side disruptions.

Third, make the transport sector competitive. Indian Railways (IR) is the life-blood of integrated India. Its declining share in transportation is a result of previous governments bleeding it for political gains. As early as 2001 the Indian Railway Report, chaired by Dr. Rakesh Mohan, laid out a road map for its commercialization. Corporatization is a first step in giving IR the autonomy to compete. Corporatisation will also encourage IR to leverage its considerable assets; use the PPP model aggressively and improve its services. Minister Suresh Prabhu is quick off the block by devolving financial powers to Regional heads to enhance efficiency and transparency in the tendering system, within the existing architecture. But formal restructuring, which requires a bargain to be struck with the unions, would make his job easier.

National Thermal Power Corporation and Bharat Heavy Electricals Limited, both companies listed on the stock exchange, are shining examples of the advantages of corporatization and listing of State Owned Enterprises and their ability to grow, even in a competitive environment. Corporatisation of IR could be followed by restructuring, including possible vertical and horizontal unbundling and a public listing to enlarge its shareholding and expose it to the discipline of the markets.

Bullet trains are a visible symbol that India has arrived. But without the enabling governance structures to sustain such hi-tech assets, today’s advances could easily become tomorrow’s “stranded assets”. It would be a pity if the “smart” cities; the industrial corridors and the bullet trains go the way of toll roads and become pot-holed, one-night wonders. Projects only feed fish. It is institutions which teach a person how to fish.

Will we veer away from the soaring flyovers; highways straight as Arjun’s arrow; high rise apartments and carefully “zoned” areas, typical of planned development and turn instead towards the squiggly, irregular lines so dear to the foreign tourist, of “charming”, little, oriental streets; buildings leaning precariously into each other; roads not wide enough to turn around a decent sized car; gloomy, shaded rooms looking inwards onto resplendent, inner courtyards with shops, factories, homes, schools and hospitals all thrown higgledy-piggledy together in the best tradition of “organic growth” fueled by private money?

Unlikely, because even the most ancient, known, Indian city-Mohenjo Daro- built in the 25th century BC was based on a rectilinear street grid (now in Pakistan) and is completely at variance with the more recent, albeit charmingly romantic, memories of traditional Indian living.

If the ancient past was at variance with recent memories, the present is rapidly evolving. Indian values and needs are changing in response to the open economy framework adopted since 1991 and the associated diffusion of technology, competition and choice. The change is so rapid that formal institutions have yet to catch up.

Neither our laws, nor our judiciary caters to the frustration of young Indians with the plethora of “limiting”, formal traditions.

Take for instance, the case of gays, lesbians and trans-genders. Our law demonises them. But most Indians are easy about adapting to them in the same way “hands-off” manner as they good naturedly, accept foreign customs, like opening doors for women ( a custom rapidly becoming extinct in the West); as a quaint sub text of life.

Cross religion marriages is another example. It is not the norm but is generally accepted if neither family objects. Young India takes to anything modern with a vengeance. Hafiz Contractor’s lurid architecture; skin fit jeans; soppy “friends” style TV serials; head banging, electronic music, offensively fast food and horribly over-priced lounges.

The rapid economic growth associated with these aspirations has usually been scaled up, to encompass the middle class, only by planned investments and heavily regulated economies, as in East Asia. The downside has been rapid grow in pockets of affluence; carefully screened off; insulated from the sordid reality of the poor. Planning to skillfully create a bubble of affluence, access into which is carefully monitored for those make the bubble real but who are excluded from the bubble, except as service providers.

But if Plans and Rules cater only to the rich does it really matter if we stop planning? Even if a random approach is adopted for public investment management there is a 50% chance that investments will benefit the rich and the poor equitably. In contrast, the Impact Assessment of Planned Programs for the poor does not have a better “hit rate” so who cares?

For starters, let us recognize that the death of Planning is not new. It died a quarter of a century ago when the Berlin Wall fell in 1989.

First, the planned share of private sector in investment has been increasing with every plan and was at 50% of total investment in the last Plan. So irrespective of how much money the government invests, so long as the private sector meets its targets we could hit at least 50% of the growth target so long as the government ensures a facilitating investment environment.

Second, public investment spend comprises just 21% of total public expenditure every year. The rest goes towards meeting the existing recurrent liabilities of interest (33%) salaries (8%) and other operating expenditure just to feed the public “beast”. Rather than increasing public investment by increasing taxes, far better to leave the surplus with private actors and encourage them to invest.

Third, of the 21% which is available for public investment there is no easy way of knowing how much needs to go for funding completion of ongoing projects and what then is the residual fiscal space for new projects. It is telling that even the Union Government budget documents are not transparent about this important distinction in resource allocation.

The suspicion is that if Fiscal Deficit targets are to be achieved there is very limited fiscal space for new projects. A careful inventory of approved but unfinanced projects could reveal a project stock as high as investment spending over the next five years. This is not new and explains why the practice has been to spend on new projects by starving existing ones, so as to please the largest number of political constituencies.

Remember that incomplete road outside your window which rakes up columns of dust every time a motorcycle zips by? Well the reason why the engineers, you curse daily, are taking so long to complete it, is that money for a road or any other project is not allocated and frozen at the time the project is approved. Allocations lapse at the end of the year and fresh allocations made against which cash is released piece meal, depending on the relative power of conflicting political constituencies.

Fourth, planning died because Planners did not reciprocate the faith put in them by citizens. They “gold plated” projects (Commonwealth Games); failed to anticipate technological change and innovation (Public Transportation) and thereby created huge stockpiles of inefficient and unsustainable assets, financed by public debt.

PM Modi probably knows this and consequently is no hurry to devise a new planning set up. Of course every government wants to leave its “footprint” encrusted in projects. The Modi government is no different, if one is to judge from the bouquet of projects hurriedly announced and allocated notional amounts in the 2014 post-election budget.

The only hope this time around, is that there may be more emphasis on creating a facilitating environment and encouraging the private sector to invest rather than using public funds to determine the future.

The test case will be Defence Production. If the government can get the domestic and foreign private sector to invest in “make in India”, against buy back assurances, we shall be starting on an even keel. Nothing much there for the poor to cheer, except some trickle down in construction and services, but at least the middle class can look forward to more jobs and better wages.

First time visitors to India are usually taken aback by our degraded cities and the seeming public apathy to sewage and garbage competing for space with Bentleys and Porches-much like puberty when it is as important to hide the pimples as it is to dress smart.

Ed Glasser of Harvard University, speaking at the LSE-NIUA “Urban AgeConference” in New Delhi today illustrates the dire situation by using the metric of vertical plus horizontal living space available per person. India’s low rise cities squeeze people much closer together-often to suffocatingly high levels- as compared to high rise cities with a similar spatial (horizontal) density.

The perplexingly happy co-existence of some of the finest hotels and monuments in the World, with the largest slum populations has multiple explanations. Some trace institutionalized urban neglect to the Mahatma’s vision of a happy India as comprising only self-sufficient villages with cities as necessary evils.

Others point to the stratified, Hindu, caste system as the reason, why spotlessly clean households and well-scrubbed people have no qualms about chucking their filth into the streets. The central concept of “ritual pollution” is a purely personal one. Public filth is a public issue and it is enough to be personally clean.

Urban government “groupies” identify the extended atrophy of municipal government in independent India, as the key reason for listless municipal governance today.

Possibly there is a little bit of truth in all these explanations and some more. But none of them are helpful in solving the problem.

The Mahatma and his thoughts have long been relegated to the realm of our “glorious past” with little salience in a rapidly growing, open economy. Spinning one’s own yarn and milking one’s own goat, even if one is a rocket scientist, negates the central concept of “comparative advantage” on which international trade is based.

The caste system has not stopped us from sending a low-cost space mission to Mars; from becoming the Information Technology back office for the West; from producing more films in Bollywood than another country in the World and becoming the most successful, largest and most diversified democracy. Blaming urban decay on caste is just plain lazy thinking.

As outdated, are those who mourn the relatively light touch of municipal government in India and the over whelming influence of higher levels of government at the Provincial and National levels.

T.S. Panwar, Deputy Mayor of Shimla at the same conference illustrated the helplessness of municipal government by calling himself the “garbage man” since that is the only unique function his municipality could legitimately claim. Of course, one may well ask why small, municipal governments need autonomy beyond the functions best performed at the local levels, like garbage management, street lighting and the maintenance of demographic records.

In this vein Harvard University Professor, Neil Brenner posits that municipal autonomy, as an explanatory variable for citizen satisfaction, in an increasingly networked world is pretty meaningless. When even nations face the prospect of losing sovereignty in monetary policy; resource use and trade policy, it is too late to target greater devolution of powers to municipalities, as a driver of high urban growth.

India’s ambition for urban led growth has to be based on the consensual transfer of resources which fuel growth, from their existing owners, to cities. Far from devolving powers downwards this means looking upwards to supra-municipal jurisdictions where meaningful negotiations can be done between rural constituencies, like sugar cane and rice farmers, who use water wastefully today and cities who should be willing to pay for incremental water. Similarly cities need to negotiate with the owners of agricultural land to buy land for growth at market rates. Meanwhile, city dwellers have to boost city revenues by paying higher taxes and “user charges” for the privilege of staying in a high growth area where jobs are plentiful and the quality of life indicators higher.

Gerald Frug of Harvard University has a similar vision in which metropolitan conclaves, comprising representatives of all municipalities, decide how people should live in cities and are empowered by their collective size and reach to negotiate with National and Provincial governments. Richard Sennet of the LSE and NYU advises the just starting 100 Smart City program, to be careful to avoid creating “stranded assets” financed by public funds, as in China. The down side of fast, lumpy investments is that what once looked like a good idea very quickly gets sidelined by technological change; shifts in business cycles and evolving trade regimes.

How can India grow beyond its urban adolescence? Some lessons are relevant.

First, for all large projects ensure that public money only leverages private investment rather than being the sole source of funding. Public resource allocation methodologies are famously inefficient. The willingness of private entrepreneurs to risk their capital by co-funding public projects becomes a plausible proxy for sound investment decisions.

Second, whilst Public Private Partnerships are consequently the chosen instrumentality for lumpy investments, both the benefits and the risks must be equitably shared between the public and the entrepreneur. Arun Nanda of Mahindra Lifespace hits the nail on the head, by stipulating that successful Public Private Partnerships never forget to ensure quantum benefits for the Community they dispossess of resources.

Third, whilst it is true that there can be no governance without an effective government, it is unwise to equate decisive governments with good governance. Good governance implies embedded systems for “direct participation” by all stakeholders to hold government accountable.

Within the good governance eco-system, the role of political parties is the least discussed and is the most deficient. China’s rapid urban development is as much due to single party rule as it is to inner party discipline. Democratic plurality is meaningless without well administered political parties which reflect democratic ideals and public accountability in their internal processes.

The helplessness of even well-meaning politicians, lower down the food chain, in the face of low traction with party bosses to solve their local problems, often reflects the top-down, stratified architecture of political parties, where “lateral entry” at the top level is the norm and meritocratic selection from within party cadres an oddity. We need more efficient, vertically integrated and transparent party structures as part of good urban governance.

The Republican sweep of the mid-term Senate elections in the US closely resembles the Modi wave in India. In both cases, electoral disgust with wooly idealism and unfulfilled promises fueled the wave.

In the US, Janet Yellen, Chair of the Federal Reserve caused a stir on October 17 by labelling as “stagnant” the living standards of the “aam” American – a seeming indictment of the last seven years of Democrat rule. She next made already raised Democrat eyebrows, merge with the hair line, by citing the inheritance of wealth as a significant pool of economic opportunity.

Both statements are anathema for the Democrats for whom income inequality is only a necessary evil and inheritance of wealth, opposed to the American dream of making good on one’s own steam. Is Yellen playing to the Republicans?

If it was India, Yellen’s strategy would be viewed as a technocrat aligning to the tune of new masters. Party lines in India are androgynous, vague and fungible in any case. Political stances on specific issues are not nuanced. When horns are locked between parties, the driver is mostly to play “spoiler” rather than differences on technical or ideological grounds.

But for a dilution of “neo liberal” ideologies in the US, close to the heart of the Democrats since Bill Clinton initiated them, is a serious event signaling a never before ideological convergence between the Democrats- associated with “big government, social protection and wealth redistribution” -and the more “conservative, small government, pro-business” Republicans.

Such a workable convergence of ideologies is sorely needed in the US, where the Republican dominated House of Representatives and now the Senate can torpedo any chance of President Obama having a meaningful second term.

The American parable has lessons for India. The handsome mandate won by the Modi led BJP in May 2014 and again recently in the Maharashtra and Haryana state assembly elections has spawned acrimony and worse, between India’s two main national parties: the BJP and the Congress. Frankly this is uncalled for. In sharp contrast the ex-PM, Manmohan Singh, who is a Rajya Sabha MP, is setting a good example by regularly and positively contributing to issues across party lines in Parliamentary Committees. PM Modi and FM Jaitley seem to have established a working relationship with the technocratic, ex-PM. This augurs well for the substance of confabulations in the parliamentary committee on Finance. We hope the Modi Sarkar (government) will expand the opportunities for such positive collaboration across party lines, especially with technocratic talent.

Media reports suggest that the erstwhile Planning Commission will be reconfigured, in early 2015, into a forum for hands-on collaboration between state government and the Union. This is just what is required.

The Modi electoral wave is shrinking the number of non-BJP state governments rapidly. Maharshtra and Haryana are now with the BJP. Delhi, which is now on way to the polls, is likely to follow. As the electoral clout of the BJP grows, it will inevitably induce a push back from threatened regional and marginalised national parties.

The British successfully used the “safety valve” of participative deliberations for decades, to secure political harmony. Bleeding opposition parties by productively engaging their technocrats can not only meet the capacity challenge the BJP currently faces, but also restrain opposition parties from being “spoilers”.

As in the US, Indian voters have “hunkered down” and adopted a black and white perspective. The choices have shrunk to either a vote for nebulous concepts of pluralism; democracy; liberalism (Congress and its spin offs) or a vote for economic self-interest (BJP and select Regional Parties). Between the two options, clearly acting in one’s economic self-interest is winning.

The Modi Sarkar has a huge opportunity to tap into this narrowing of the voter expectations. Here are two steps which can play to their new expectations:

First, after wowing the young electorate with a media savvy, electronically charged campaign, the likes of which has never been seen in India, the Modi Sarkar cannot now tamely go back to the netherworld of the paper file bound by red tape.

Google, Microsoft and Apple can facilitate real time digital communication between government, business and citizens. But unless connectivity become pervasive; the quality of access improves and the cost of access is resonable, large swathes of our citizens remain excluded.

More importantly, what use is it for a citizen to record and report crime instantly, using a smartphone, if the response time of the police and medical teams runs into hours if not days? Unless government processes are digitized to seamlessly integrate digital inputs and establish electronic audit trails of action taken, vast pools of sloth and inefficiency will continue to confound citizen expectations.

We are not moving up the ladder of digitization of public systems and interface fast enough, thereby keeping transparency, accountability and participation levels very low. Can the PM set May 27, 2015-a year since assuming office- as the deadline after which all submissions to the PMO must be electronic?

Second, young voters are unlikely to be impressed with the hoopla around the skills agenda as it currently exists. Even skilled workers do not have jobs today. Our 3000 engineering institutes churn out 1.5 million graduates every year, many of dubious quality. Around one half waste the skills acquired as no jobs exist. Jobs can only be created over time. During the interim a “holding strategy” is needed.

The skills agenda is a copy of the “holding strategy” in developed countries, where kids without jobs can continue studying at state expense. This is extremely wasteful. Far better, in the Indian context, to incentivize kids early to opt for learning-on-the-job. The traditional system of learning under an “Ustad” (mentor) can be kick started by publicly funding 5 million long term-2 to 3 years- apprenticeships.

Business would welcome the move for two reasons. First, public funding dilutes the cost of training a low-skilled, young employee, who could leave after her apprenticeship. Second, businesses get to train employee in the skill-set per their specific requirement. They are far better placed to impart job related skills than vocational schools, established under traditional, technical training programs, at high cost, but no direct linkage to jobs.

For employee the on-the-job-training is a costless opportunity to network and to add skills with an eye to the future.

Clearly, there are downsides to this proposal. Employment in the formal, private sector is shallow at only 13 million. Apprenticeships in the suggested volumes just cannot be absorbed in the formal sector. In the non-formal sector, unfair capture of benefits by family members of the business owner is a possibility. But competitive grant of apprenticeships can overcome this problem. Also the scheme does not come cheap and could cost 1% of GDP or 5% of the government’s budget.

But just as clearly there are upsides. The political benefits are obvious: 15 million young voters and 50 million satisfied family members, spread across India, all of whom have benefited directly from the scheme by 2019 (next general elections).

More substantively, publicly funded apprenticeships can democratize access to non-formal private sector jobs by encouraging the entry of other than family members. The public subsidy for financing the learning curve can incentivize the hiring of deserving but un-networked and financially insecure, young workers.

The incremental fiscal burden, whilst not insignificant, is easily absorbed by rationalising the wasteful, legacy, central sector schemes spawned by the erstwhile Planning Commission which amount to more than 4% of the GDP. Also funding apprenticeships is one way of increasing our miserably low allocation of public resources for education.

The hardest thing in public resource allocation is to quantify tradeoffs. But helping a young worker get hands-on experience, as a first step towards a real job, is surely pretty high up as a national priority.